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New Trouble for Euro in Portugal

Just weeks after European leaders tamped down a banking crisis in Cyprus, troubles in the euro zone have again reared their head, this time in Portugal.

In an address to his beleaguered nation on Sunday, Prime Minister Pedro Passos Coelho warned that his government would be forced to cut spending more and that lives “will become more difficult” after a court on Friday struck down some of the austerity measures put in place after a bailout package two years ago.

The renewed tension in Portugal raised the threat of further trouble elsewhere in the euro zone, where ailing members have struggled to rebuild economic growth after enduring wrenching spending cuts.

“The risks in the euro zone have increased markedly over the past six weeks or so,” wrote Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London-based consultancy that assesses risk on sovereign debt.

A critical moment for the latest trouble took place on Friday, when Portugal’s Constitutional Court struck down four of nine contested austerity measures that the government introduced as part of a 2013 budget that included about 5 billion euros, or $6.5 billion, of tax increases and spending cuts. The ruling left the government short about 1.4 billion euros of expected revenue, or more than one-fifth of the 2013 austerity package.

Specifically, the court, which began reviewing the legality of the government’s austerity measures in January, ruled as unconstitutional and discriminatory the government’s plans to cut holiday bonuses for civil servants and pensioners, as well as to reduce sick leave and unemployment benefits.

Since Greece’s bailout in 2010, spikes in the borrowing costs of troubled euro countries have spread from one country to another as investors have tried to anticipate possible problems elsewhere in the currency union.

With that contagion risk in mind, politicians in Spain wasted no time over the weekend trying to distance their country from the latest turmoil in Lisbon.

Esteban González Pons, a senior official of the governing Popular Party, told a gathering of the party on Sunday that “Spain is not in the situation of Portugal.” He added, “If Portugal is in worse shape than Spain, it is because they have not taken the necessary measures that we have taken in our country.”

In May 2011, Portugal became the third euro zone country, after Greece and Ireland, to negotiate an international bailout. Lisbon received 78 billion euros from the International Monetary Fund and European creditors in return for introducing spending cuts and tax increases. Since then, however, Portugal has failed to meet its promised budgetary goals. Its economy has instead continued to sink into one of Europe’s most severe and prolonged recessions, spurring labor strikes and huge street demonstrations.

But Mr. Passos Coelho, in his first public address since the court ruling on Friday, defended the record of his nearly two-year-old government and pledged to do “everything to avoid a second bailout.” He ruled out, however, introducing tax increases.

Photo

Prime Minister Pedro Passos Coelho warned of spending cuts and difficult times ahead in an address to the nation on Sunday.Credit
Mario Cruz/European Pressphoto Agency

The prime minister addressed the nation on Sunday after an emergency meeting of his cabinet on Saturday, as well as talks with the Portuguese president, Anibal Cavaco Silva.

Cyprus received a bailout of 10 billion euros from international creditors last month. It may need even more to save its banks, a top German policy maker said on Sunday.

“The situation in Cyprus has stabilized in the last few days,” Jens Weidmann, president of the Bundesbank, the German central bank, told Deutschlandfunk radio. “However, I wouldn’t rule out that the need for liquidity in Cyprus could increase.”

The crisis in Cyprus reflects how urgent it is for the euro zone to establish a means to shut down failed banks without burdening taxpayers or endangering the financial system, Mr. Weidmann said.

“There continues to be a problem with banks that may be too connected and too big to wind down without creating a danger for the financial system,” he said.

After the Portuguese court ruling on Friday, António José Seguro, the leader of the main Socialist opposition party, urged Mr. Passos Coelho to call an early general election. Two years ago, a Socialist administration was forced to resign and call a snap election after failing to win sufficient parliamentary backing for its own program of austerity measures.

Unlike the Socialists at the time, Mr. Passos Coelho holds a comfortable parliamentary majority, at the helm of a coalition between his Social Democrats and the smaller, conservative Popular Party. Mr. Passos Coelho and lawmakers from his governing center-right coalition on Wednesday defeated a motion of no confidence in Parliament, which had been backed by the Socialists.

Portugal is aiming to cut its budget deficit to 5.5 percent of gross domestic product this year from 6.4 percent in 2012, but that target has recently been put into question by economists because of a deepening recession that has also pushed Portugal’s unemployment rate close to 18 percent, compared with 12 percent when Mr. Passos Coelho came to power two years ago.

While the Constitutional Court’s ruling is a blow for the government in terms of its credibility and budgetary plans, it also gives Mr. Passos Coelho new arguments to persuade international lenders to grant Lisbon additional leeway in meeting its budgetary targets, according to some analysts.

Mr. Passos Coelho said on Sunday that he would seek to explain to creditors how the court’s ruling had left Portugal “in a situation of great difficulty.”

International lenders have already agreed to give Portugal until 2015 to cut the deficit to 3 percent, which is two years later than was agreed two years ago, when the bailout was negotiated.

“It was already clear that Portugal would not meet its budgetary targets anyway, even without this court decision,” said Pedro C. Magalhães, a professor of politics at the University of Lisbon. “The government wants to make it absolutely sure, before the public and especially before our creditors, that it is perceived as having done all it could, that the blame for failure is shifted to the court and that any further relaxing of budgetary targets is seen as being forced by unforeseen circumstances and not by the government’s own lack of commitment.”

Despite Portugal’s recent budget slippage, the I.M.F. has maintained its confidence in the government of Mr. Passos Coelho, especially after Lisbon managed to return to the bond markets in January with a debt issuance of 2.4 billion euros. Lisbon was expected to follow up on that improvement soon by issuing 10-year benchmark bonds for the first time since the bailout.

Jack Ewing contributed reporting.

A version of this article appears in print on April 8, 2013, on page B1 of the New York edition with the headline: New Trouble For Euro In Portugal. Order Reprints|Today's Paper|Subscribe